Now what (part deux)?

The strong September employment data announced in the US last Friday effectively derailed expectations of another 50 basis point Fed rate cut any time soon. So how will markets react to the Canadian employment data released this morning, which are even stronger?

Per Statistics Canada, the Canadian economy added 47,000 jobs in September, after several months of little change. The increase served to push the unemployment rate slightly lower, to 6.5 percent, ending a long run of gradual increases. Details of the report were generally robust: there were 61,000 new private sector jobs in the month, offset by some job losses in the public sector; full time employment rose by 112,000; the job gains were well-dispersed across the country, with only BC and New Brunswick reporting lower employment; and hourly earnings rose 4.6 percent from a year earlier, lower than in August but still well ahead of inflation.  

Despite all these signs of strength, there are still some lingering issues. The employment rate (i.e. the percentage of the working-age population actually in employment) continued to edge lower in September despite the strong jobs gains. This reflects Canada's very rapid immigration-driven population growth. The national population rose an estimated 110,000 in September, to stand almost 1.2 million (or 3.6 percent) higher than a year earlier. The unemployment rate only ticked lower because the labour force rose by a surprisingly small 16,000 in the month.

The strong employment data seem to give the lie to the significant number of media types and other experts who have been loudly declaring that the Canadian economy is "already in recession", which it clearly is not. There have been suggestions that the Bank of Canada might follow the Fed in implementing a 50 basis point rate cut in the near future. With the Fed now likely to follow a more cautious path for a while, today's data show there is no compelling reason for the Bank to deviate from its current policy of gradual easing. 

Now what?

September's non-farm payrolls report, released this morning by the Bureau of Labor Statistics, came in way above market expectations. What does this mean for the US economy and for the direction of Federal Reserve policy? 

Employment rose by 254,000 in September, more than 100,000 above the level markets had expected. This is comfortably higher than the average monthly gain of 203,000 posted over the past twelve months. Moreover, the relatively weak monthly increases reported for July and August were revised higher by a total of 72,000 jobs.  For the second straight month, the unemployment rate ticked down, to stand at 4.1 percent. Average hourly earnings rose 0.4 percent in the month to stand 4.0 percent higher than a year earlier, and are now reliably running ahead of the rate of inflation. 

Recent Fed-speak, including the statements made after last month's FOMC rate cut, have clearly shown that the Fed is now largely convinced that it has got inflation under control, allowing it to focus more on signs of weakening in the jobs market. To the extent that the Fed was using the July and August non-farms data as evidence of that weakening, the upward revision of the data for those months might be seen as a sign that the 50 basis point cut was an over-reaction. The strong September data certainly suggests the same thing. In that case, it would be reasonable to expect that the two remaining FOMC meetings this year will bring smaller rate cuts, or even conceivably a pause in the easing cycle as the Fed waits for more data to come in. 

There are at least two factors complicating the near-term rate outlook. First, the October jobs numbers are likely to be messy, thanks to the strike at Boeing, the strike (albeit now over) at East Coast ports and the lingering impact of Hurricane Helene.  (Note, however, that in reporting today's numbers the BLS said that Helene has had no measurable impact on the data).  These factors may all bias the October data downwards, but given the statistical "noise" in the numbers, the Fed will react cautiously. Second, the ever-expanding mayhem in the Middle East may push global oil prices sharply higher, which would affect prices in the US even though it is no longer reliant on energy supplies form that region. 

The next FOMC meeting is set to take place right after election day.  While it is quite possible (to say the least) that the outcome of the vote will not be known by the time the Fed makes its announcement, there is no risk that whatever decision is announced can be construed as "political". Barring any major surprises in the data flow, the likeliest outcome in both November and December is for a 25 basis point rate cut, but a pause in the easing cycle becomes more likely as we move into the new year. 

Doing things by halves

The US Federal Reserve today launched the widely-anticipated easing cycle with a full 50 basis point rate cut, dropping the fed funds target range to 4.75-5.0 percent. Market expectations had gravitated toward a move of this size in recent trading sessions. Interestingly, and unusually in recent times, one FOMC member, Michelle Bowman, voted in favour of a 25 basis point cut.  

The media release  is surprisingly anodyne, considering how much weight markets had been placing on today's decision. The key passage is this one: The Committee has gained greater confidence that inflation is moving sustainably toward 2 percent, and judges that the risks to achieving its employment and inflation goals are roughly in balance. The economic outlook is uncertain, and the Committee is attentive to the risks to both sides of its dual mandate.

Alongside the media release, the Fed has released updated economic projections. The widely-followed "dot plot" shows that a small plurality of FOMC members expect the funds target to fall by a further 50 basis points by year end. (Reminder: there are two more FOMC meetings scheduled for the remainder of 2024). Further easing is expected through 2025, with the funds target expected to end that year at about 3.25 percent. 

The risk for the Fed in starting the easing cycle with an outsized cut is that investors might assume the economic situation is much worse than previously thought, leading to a selloff in equity markets. Evidently the messaging from the Fed ahead of the announcement has worked, because the initial reaction on Wall Street has been a modest move higher. Markets will now focus on Chair Jerome Powell's press conference for clues about whether there are more large rate cuts on the horizon: fearless prediction, Powell will say it all depends on the data. 

Right on target!

Canada's headline CPI finally returned to the Bank of Canada's target in August, falling 2.0 percent year-on-year from the 2.5 percent posted in July, according to data released today by Statistics Canada. This was the lowest annual increase since February 2021.  

The chief contributor to the fall in the headline rate was the price of gasoline, which fell 2.6 percent in August to stand 5.1 percent lower than a year ago. However, the easing in inflationary pressures is broad based, as shown by the fact that CPI excluding the cost of gasoline slowed to 2.2 percent in August from 2.5 percent in July. The one truly sticky sub-component continues to be shelter costs, up 5.3 percent from a year ago. Amid continuing rapid population growth, there is little prospect of any relief in this area. 

The Bank of Canada's three preferred measures of core inflation all eased in August. Their mean value now stands at just over 2.2 percent and one of them, "CPI-common", now stands exactly at the Bank's 2 percent target.

In making its latest rate reduction earlier this month the Bank warned that the base effect could briefly turn unhelpful late this year, pushing headline CPI readings higher. That warning remains relevant, but there is no doubt that the Bank is now in a much better position to focus its attention on supporting the real economy and the employment market, rather than exclusively on combatting inflation. Depending on how the data look in the coming weeks, the possibility of at least one 50 basis point rate cut before year-end has clearly increased. 

And lastly, just for some light relief, I can't resist quoting the headline from the CBC website's report on today's data:  "Canada's inflation rate finally hit the Bank of Canada's target. What does that mean for prices?" Well, duh. 

US economic policy: bad ideas galore!

What with all the insults, threats and bizarre assassination attempts. one aspect of the ongoing US Presidential election campaign is going largely unnoticed.  Both candidates are wheeling out some of the most ridiculous economic policy proposals in living memory.  Here are just a few.

The biggest and potentially most damaging proposal is Donald Trump's pledge to impose tariffs on just about everything the US imports, with a view to reducing income taxes. It's clear that his Wharton degree did not equip him to understand how tariffs work.  He believes that any tariffs he introduces would be paid by foreign countries. It does not seem to occur to him that either (a) the tariffs would be passed on to US consumers, thus rapidly pushing up inflation, or (b) countries and companies would simply stop shipping their products to the US, in which case the tariffs would not produce any revenue and the shelves at WalMart and just about everywhere else would rapidly empty.

What's worse, it's impossible to imagine that foreign countries would not react to Trump's tariffs by retaliating with their own tariffs on American exports. As the experience of the 1930s showed, that's a recipe for a global recession, or worse -- and the global economy is much more closely integrated now than it was in the 1930s.

Sticking with Trump for the moment, his latest genius idea is to exempt all overtime earnings from income tax. He affects to believe that this would promote and reward hard work, but the likely consequence is surely the exact opposite.  How many tasks that workers are currently able to accomplish in a 40-hour work week would suddenly start to consume more time, compelling employers to pay overtime? How many new jobs might never be created as existing workers start to demand overtime rather than allowing the employer to add new workers?  And how would this be implemented for salaried workers, many of whom routinely work more than forty hours a week? (Asking for a friend on that last one, obviously).

Let's give Kamala Harris a look-in here. One of her off-the-wall proposals is to introduce taxation of unrealized capital gains. Now, it's clear enough that the immense book wealth of the Musks and Zuckerbergs of this world is a very tempting target for revenue-hungry politicians, but is this really a workable idea? The nature of unrealized gains is that you don't have the cash on hand to pay the tax.  Do you sell assets to pay it, in which case you now have a realized capital gain anyway? Or do you borrow the money, thereby making your balance sheet more risky? 

Does the unrealized capital gains tax apply at all income levels, in which case the impact on small to medium sized entrepreneurship is likely to be severe? Or does it only apply above a certain cutoff point, which no doubt triggers all manner of accounting shenanigans?  And what happens if, after you pay the tax on unrealized gains, you run into a period of losses?  Do you get your money back?

Lastly there's a silly idea that both candidates have embraced: removing income tax on tips.  I blogged about this one back on August 13, so allow me to quote myself: 

Basically, the case not to do this comes down to the good old Law of Unintended Consequences.  One: eliminating taxation on tips directly reduces any incentive for employers to pay their staff a living wage. Two: in all likelihood it reduces the percentage that customers actually tip -- "hey, I've paid tax on this money that I'm tipping you, but you won't be paying tax on it, so it's only fair that I give you less, right?" Three: eliminating taxation on tips creates incentives for smart people to structure their compensation in order to take advantage. Ready to start tipping your investment broker? Just give it time. 

Heck, not just your investment broker.  Your realtor just lowered his fee from 6 percent to 4 percent, but the sales agreement now includes a provision for a 2 percent tip, and that tip is, of course, mandatory.

This is a scary list of dumb ideas, and I'm sure there are quite a few more that I've missed.  We can assume that most of them will never be heard of again after November 5, but the very fact that the candidates are even thinking on these lines is pretty worrisome. 

There's no pleasing some people

Sometimes there's no pleasing the markets, and this seems to be one of those times. Today the BLS reported that headline CPI rose 2.5 percent in August from a year ago -- down from 2.9 percent in July, below market expectations and the lowest reading since February 2021. At first blush that would seem to reinforce the possibility that the Fed will start its easing cycle with a 50 basis point cut later this month.  But no: markets sold off heavily in the wake of the report, with the DJIA falling by as much as 700 points at one stage. 

According to CNN, the seemingly perverse market reaction happened because investors chose not to look at the headline number, but rather to focus on core CPI, which posted a 0.3 percent month-on-month increase, to stand 3.2 percent higher than a year ago. Given the Fed's focus on core measures, that makes some sense. However, another possible explanation suggests itself.  The sharp fall in the year-on-year headline number is largely the result of a favourable "base effect", as large gasoline price increases a year ago fell out of the calculation. Up here north of the border, where something similar has been observed,  the Bank of Canada has been warning that such effects often prove transitory. A similar concern may well be appropriate for the US. 

Prior to today's report, futures markets had been pricing in as much as a one-third possibility of a 50 basis point rate cut this month. That has now been hastily unwound, with a 25 basis point rate cut now seen as by far the likeliest outcome. 

Fifty from the Fed?

How you view the August non-farm payrolls report, released this morning by the Bureau of Labor Statistics,  depends on whether you're a glass half empty or a glass half full type of person. Glass half empty?  Well, the employment gain of 142,000 was lower than market expectations (which had looked for 160,000) and way lower than the 202,000 average posted over the past twelve months.  Glass half full?  The monthly gain was significantly higher than the July result, which was revised lower to a gain of 89,000 from the 114,000 originally reported, and the unemployment rate actually ticked lower, to stand at 4.2 percent.  

The reaction in markets suggests that most investors think the Fed is in the glass half full camp. In recent days expectations had been building that the Fed might front-load its easing cycle with a 50 basis point cut at the FOMC meeting on September 18, but that expectation has now been scaled back, with a 25 basis point cut seen as more likely. 

Fed Chair Powell never seems to be in a hurry. Arguably, both the post-COVID tightening cycle and the still-pending easing cycle should have started sooner. It would be un-Powell-like to start the easing cycle with an oversized cut. That could be interpreted as a sign that the Fed thinks it has fallen behind the curve, and could also create expectations for further large rate cuts. The Fed would undoubtedly prefer to avoid both of those possibilities. Expect a 25 basis point cut this month, with the FOMC statement indicating more of the same to come, while emphasizing that the Fed has flexibility to act more vigorously should the need arise. 

Meanwhile in Canada, where the easing cycle is, as hockey commentators sometimes like to say, nicely under way, the August employment data leave the way clear for further rate cuts. After three months with almost no gain in employment, the economy created 22,000 jobs in August -- but that headline figure hides the fact that 44,000 full time jobs were lost in the month, with the overall gain entirely attributable to a surge in part-time employment.

The unemployment rate continued its inexorable rise, increasing by 0.2 percentage points in the month to stand at 6.6 percent. As has been the case for many months now, the rise in unemployment is almost entirely the result of relentless growth in population. After taking a surprising pause in July, the labour force surged by 82,500 in August, on the back of a 96,000 increase in the national population. 

It helps to look at some of these figures over a slightly longer time frame. Over the past year, the economy has added 316,000 jobs, an increase of about 1.6 percent. In more normal times, this would represent a very respectable performance. However, over the same time period Canada's population has risen by 1,150,000 and the labour force has grown by 588,000. There is no imaginable set of economic policies that would allow the economy to absorb this many new workers. 

Today's data do not change the outlook for Bank of Canada policy. Further 25 basis point rate cuts will come at the two remaining fixed announcement dates this year and the cycle will no doubt continue well into 2025.  However, the Bank will be well aware that it can do little or nothing to prevent the  unemployment rate from edging ever higher.